Sunday, July 11, 2010

Prepare For Tax Hikes & Budget Cuts

The world economy is reaching a point of stagnation, and perhaps contraction will follow. Consumption has dwindled. However, we live in a perpetual growth system that cannot handle this sort of pullback.

So governments around the world have jumped into the breach with absolutely massive stimulus programs designed to rekindle growth. Under the current economic model, if you're not growing, you're dying.

However, all of this government spending has led to a run-up in government debts. As we've seen in Europe, this spooks markets and can lead to a credit crisis. That can make it difficult, if not impossible, for nations to borrow money. And even if they can, the costs are prohibitive.

As a result, the G-20 nations have pledged to cut their deficits in half by 2013, and to "stabilize or reduce" their debt-to-GDP ratios by 2016.

The debt-to-GDP ratios of some of the world's largest economies — including the U.S. and U.K. — are stunning and potentially dangerous.

The U.K., the world's seventh largest economy at $2.1 trillion, is facing a massive debt burden and a depressed currency. The U.K. faces a deficit that is 12.5% of GDP (similar to Greece), and a national debt equaling 72% of GDP. But when private debt is added, things get a lot worse.

A study by the McKinsey Global Institute found that the U.K. has the world’s worst private and public debt in comparison to GDP, with a ratio of 470%. Yet, due to artificially low interest rates, the problem stands to get a lot worse as those rates inevitably rise.

In an effort to address its fiscal shortfall, the U.K. government outlined a budget intended to eliminate its structural current deficit through a combination of spending cuts, a two-year public sector pay freeze, a bank levy, and tax increases.

U.K. Chancellor of the Exchequer George Osborne announced an immediate increase in the capital-gains tax paid by higher earners from the current 18% to 28%, and the value-added tax will increase from 17.5% to 20% in January, 2011.

This is what the U.S. has to look forward to; tax hikes and budget cuts.

The U.S. is currently facing a current budget deficit that is 10% of GDP, and the 2011 deficit is projected to rise to 11% of GDP. Meanwhile, the national debt recently topped $13 trillion. The long-run projections of the Congressional Budget Office suggest that the U.S. will never again run a balanced budget. Imagine that.

If the U.S. were to cut its projected 2010 deficit in half by 2013 — as agreed to at the G-20 summit — that would be a cut of $780 billion. This will result in a lot of pain for a lot of people. There is no easy way out. It's going to hurt a lot.

However, the Obama administration recently said it will work to reduce the U.S. fiscal deficit to 3% of GDP by 2015. That would amount to a $994 million budget cut.

While these reductions are desperately needed, they will severely impact the lives of tens of millions of Americans.

Since two-thirds of the federal budget is comprised of Social Security, Medicare, payments to veterans, and interest on the national debt, cuts to these items will range from painful to impossible. The U.S. cannot — will not — default on its debt payments, so the cuts will come from the aforementioned entitlement programs.

The government will not be able to significantly reduce the debt it has recklessly run-up unless it does it on the backs of the American people. Many of them will be the most vulnerable; the elderly, the disabled, the poor and the unemployed.

The effects of budget cutting will be brutal and lasting. And it seems that day of reckoning will soon be at hand.

Undoubtedly, the bloated military budget should be — needs to be — significantly reduced. But that's a story for a future article.

To be continued....

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